How To Counter Inflation

What's your strategy to counter inflation? In this issue: » Buy gold to protect yourself from inflation, says Marc Faber » Deficit figures concern Pranab Mukherjee » Credit ratings are fudged, says Moody's whistleblower » Mutual fund intermediaries beware » ...and more!

The US Federal Reserve has said that although economic activity is picking up, it plans to keep interest rates close to zero for an extended time. This is after US interest rates have fallen steadily from a high of 5.25% since September 2007. Central banks around the world have resorted to a soft interest rate regime to jump start their economies that went into a shock from the global financial meltdown.

We wonder if the prolonged availability of easy money will extract a really steep price from us in the days to come. The longer such easy money is available, the greater are the chances that it will find its way into several asset classes and create bubbles there. It is most likely to also cause runaway inflation i.e. devalue the purchasing power of currency. In fact, Warren Buffett has recently sounded a warning that the US risks becoming a banana republic if the monetary medicine is administered for a prolonged period.

In fact, commodity guru Marc Faber advises investors not to be fooled by the Fed's assurances that it will keep inflation in check. It simply cannot, given the pressure to print money due to hue huge debt sitting on its books. Further, Mr. Faber has added that it is very important for everyone to own some gold because the US government will make the dollar useless. Although commodities in general do well in times of runaway inflation, Gold is traditionally the most favoured anti-inflation play. In our opinion, businesses with strong franchises will also be able to counter inflation. Those rare businesses that have the ability to raise prices without losing volumes.

01:07 Chart of the day If one were to analyse the fundamentals of a country, one of the key areas would have to be the level and quality of education that its citizens receive. While India boasts of some great institutions of higher learning, its primary education leaves a lot to be desired. We are not even talking about the quality of the primary education, which is another topic. The reach of primary education in India remains poor. Today's chart

shows the nations with most number of children who should be attending school, but are not. India has the dubious distinction of securing the second spot in the list. And it is not merely because India is a populous country. After all, the one country with a greater population than ours and also rapidly marching out of its 'emerging market' status – China – is conspicuous by its absence. Interestingly, the most affluent country in the world, the US, also has a tough time putting all its children in school. In our opinion, this is one area that needs urgent attention, if India has to fulfill its dream

of becoming an economic superpower. Note: Latest data as of 2006. Ethiopia and US as of 2007 Source: UNESCO institute of statistics, August 2009.

02:06

Although the hopes of India clocking a better GDP growth rate (6%) in FY10 as compared to earlier projections gather momentum, burgeoning fiscal deficit remains the bone of contention. India's Finance Minister Mr. Pranab Mukherjee has recently cited his concerns with regard to controlling the deficit figures. According to him, the drought condition coupled with the financial crisis has only added pressure on the government budget. The government has stepped up its development outlay to the extent of 39% this year primarily financed through borrowed resources. Of this, Rs 2.8 bn was given out through stimulus packages. If the Centre's tax collections are not adequate to fill in the gap, the year's fiscal deficit may even cross 11% of GDP. It may be noted that the government has set a target of bringing the fiscal deficit down to 5% of the GDP by 2011 and 4% of the GDP by 2012. We believe that these are very ambitious targets in the current scenario.

02:48

With SEBI planning to bring in transparency in the way mutual funds operate, investors can breathe a sigh of relief. As reported in a leading business daily, the SEBI has issued a code of conduct for intermediaries, including distributors of mutual funds. According to it, asset management companies (AMCs) have been told not to deal with non-compliant intermediaries and should report such cases to the Association of Mutual Funds in India (AMFI) and SEBI. This follows on the heels of the directive in June this year which called for transparency in payment of commission and the load structure and thereby mandating distributors to disclose all commissions. Amongst other things the code proposes to check malpractices and ask the distributors not to assure returns to clients. We believe that given how certain transactions in the mutual fund industry had become murky, it had become necessary to impose regulations so that investors' interests were protected. While it was high time that the SEBI stepped in to rally around investors, we believe the key is how the code is implemented.

03:23

Recently, in a study of the compensation received by the CEOs of the world's largest banks in 2008, it was found that out of the 5 highest figures, 4 were from the US. One might think that it is not possible to recruit CEOs without hefty compensations. Not quite. The CEO of world largest bank, Industrial and Commercial Bank of China, received US$ 0.2 m in 2008. The CEOs of Commonwealth Bank of Australia and HSBC, UK

received US$ 8 m and US$ 3 m respectively. A far cry from US$ 20 m package at JP Morgan Chase and US$ 14 m at Wells Fargo!

04:00

At times, it takes a whistle blower to speak the truth! A recently suspended managing director of credit rating major Moody's, Eric Kolchinsky, has alleged that the company has been fudging credit ratings in order to generate more revenues. He says Moody's methodologies of rating complex securities were inadequate in realistically reporting the underlying risk and that the analysts were bullied to award ratings in favor of revenues. This revelation comes at a time when US regulators are mulling over regulating credit rating agencies, which played a part in causing the global meltdown by conferring investment grade rating to junk securities. In our opinion, it is only fair that rating agencies took a thorough look at the conflict of interest in the credit ratings business.

04:29

Meanwhile, after yesterday's nosedive, the BSE-Sensex opened on a negative note today. Despite attempts to recoup the losses during the day, the index remained in the red. At the time of writing the BSE-Sensex was trading 103 points below the dotted line. However, the BSE Small-cap index was trading marginally in the positive. As for global markets, Asia ended the day on a mixed note, while the European markets are currently trading in the red.

04:48 Today's investing mantra

"Warren (Buffett) and I have skills that could easily be taught to other people… But Warren and I are better at tuning out the standard stupidities. We've left a lot of more talented and diligent people in the dust, just by working hard at eliminating standard error." - Charles Munger